“Too close for missiles, I’m switching to guns.”
As a Thunder Bay boy with a lot of testosterone growing up in the 80’s, there weren’t many movies that beat Top Gun. Admittedly, I’m a little competitive, so pardon my passion this morning – “Goose, it’s time to buzz the tower.”
“The son of a bitch cut me off!” in telling the world my call on the Long Bond (TLT) is wrong yesterday. I don’t know the guy, so it’s not personal. I just flat out disagree. That guy, you know – the New Jersey Consensus TV folks love him. His name is Tepper.
Tweeters say that David Tepper A) has a lot more money than me and B) has killed it on the levered long side since 2009. He also flamed out in 2008 (down -29.61%), so on his rising rates call, I think he’s beatable. “I think I’ll go embarrass myself with Goose now.”
Back to the Global Macro Grind…
What we need in this game is more head to head debate. Pro to pro. When someone flips me off with the other side of my position, I want to crush him. I don’t care how much he’s worth or what he’s wearing. I wear a $29.99 watch from WalMart, and I like it.
While I’d love to debate Tepper live on interest rate risk (which I still think is to the downside), the reality is that probably won’t happen. (if you know him and he’s game however, I have a nice little 2.0 studio in Stamford called @HedgeyeTV).
Debating big macro topics isn’t personal. It’s what those of us who want to be the Top Gun wake up thirsting for at the top of every risk management morning. Last year I was making the call that rates would rise alongside both US growth expectations and the Fed being forced to taper. This year I reversed the call saying that rates would fall as y/y #inflationAccelerating slowed real US growth.
Yeah, sweet call Mucker. “Take me to bed or lose me forever.”
God didn’t call me with the rates call. My team and I made this call the old fashioned way, using our own models and process. When it comes to what other players out there think, we respect their airspace, but when we get in tight in a dog fight like this, we aren’t going to back down.
Here are 10 things to think about in terms of why rates are going lower (bonds higher) from here:
- US GDP growth slowing sequentially in Q3 vs Q2 of 2014
- US GDP growth continuing to slow, year-over-year, in 2014 versus the Q3 2013 #GrowthAccelerating top
- US GDP entering an early cycle slowdown (bearish on Housing, Consumer, Regional Banks)
- US Housing demand not responding to the downside surprise in interest rates
- All of Europe slowing in 2H 2014
- Japan slowing Q4 2014
- Japanese and German 10yr yields of 0.53% and 0.96%, respectively
- Institutional Fund Flows reverting back to their slow-growth mean (into bonds, out of stocks)
- US 10yr Yield immediate-term TRADE resistance = 2.51%
- US 10yr Yield intermediate-term TREND resistance = 2.81%
The biggest differentiator in our models versus those who were bearish on rates in 2013 (and bullish on them in 2014) is our rate of change forecasts on both growth and inflation.
I have stopped calling it our Growth, Inflation, Policy Model and renamed it our PIG model (same factors, in reverse). Why? Because un-elected central planners are pigs when it comes to devaluing the purchasing power of The People in exchange for asset inflation.
To review how all 3 (Fed, ECB, BOJ) of these central planning committees think:
- When growth slows, they get easier (print money, or threaten to do “whatever it takes”)
- As they get easier, their currencies fall, and the real cost of living in their countries rises
- As cost of living rises, real consumption growth falls faster, and they ease again
Top 2 headlines on Bloomberg (Economy Go!):
- “Draghi Sees Almost 1 Trillion in Stimulus”
- “Aso Signals Japan Prepared To Boost Stimulus”
Aso, as in the one who tore the Japanese people a new one via the Abenomics Policy To Inflate that took Japanese Real Wages to -4-5% year-over-year. Then they blamed the weather. #Nice
If the USA shows as much as a sniffle in this morning’s jobs report, what do you think Yellen’s response is going to be? Tighter or easier? We’re one or two bad labor headlines away from the US doing exactly what Draghi just did.
Unlike Tepper, I fly commercial. But I can still change my position whenever I want. For now, if I am right on growth slowing and the Fed’s proactively predictable reaction to it, Janet is going to be my Japanese wing-woman on bonds.
Out immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.32-2.46%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – September 5, 2014
As we look at today's setup for the S&P 500, the range is 29 points or 1.03% downside to 1977 and 0.42% upside to 2006.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.91 from 1.92
- VIX closed at 12.64 1 day percent change of 2.27%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Change in Nonfarm Payrolls, Aug., est. 230k (pr 209k)
- Unemployment Rate, Aug., est. 6.1% (prior 6.2%)
- 1pm: Baker Hughes rig count
- 3:45pm: Fed’s Rosengren speaks in Boston
- Senate, House out on final week of summer recess
- President Obama views fly-over ceremony, attends NATO summit in Wales, holds press conference, returns to Washington
- 10am: Nebraska Supreme Court hears constitutionality arguments on Keystone XL pipeline route through state
- U.S. ELECTION WRAP: Kansas Senate Race; Koch-Backed Ads
WHAT TO WATCH:
- Jobs-Day guide: U.S. payrolls, participation, wages and hours
- Barclays, Citigroup accused in suit of manipulating ISDAfix
- Apple plans new security features after hack of celebrity photos
- Ukraine ready for truce as NATO cautions on Russian peace offer
- Gap falls as August same-store sales trail analysts’ estimates
- Keryx has 82% chance of winning FDA Zerenex approval: analysts
- Nvidia sues Samsung, Qualcomm after patent deal talks fail
- German industrial production expands in sign of eco. rebound
- Eurozone GDP stagnates in 2Q; flash reading unchanged q/q
- Median incomes fell for all but richest in 2010-13, Fed says
- Swaps rule requires $644b in collateral, regulator says
- Autonomy CFO told Lynch of "imaginary deals’’ before HP sale
- Dollar General’s Family Dollar bid may not be enough: Reuters
- Bain Capital’s Atento may start U.S. IPO next week: Reuters
- Apple files reality navigation patents: AppleInsider
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Long-Term Oil Demand to Slow Even With Higher China Consumption
- Copper Rises in London Before U.S. Jobs as Surplus Seen Elusive
- Chemical Boom at Risk as U.S. Ethane Heads Abroad: Commodities
- WTI Heads for Weekly Drop as Refiners Slow Rates; Brent Steady
- Raw Sugar Extends Drop to 7-Month Low While Arabica Coffee Falls
- Gold Is Little Changed Near 12-Week Low Before U.S. Jobs Data
- Sugar Output in India’s Biggest Producer Seen at Three-Year High
- Corn Rebounds as Cooler U.S. Temperatures Raise Frost Concern
- Russia Reports Outbreak of Classical Swine Fever in Southwest
- Rebar Posts Biggest Weekly Loss in 15 Months as Demand Wanes
- Palm Trims Biggest Weekly Gain Since November as Reserves Climb
- Pears Rot in Europe as Putin’s Retaliation Pushes Price Down 70%
- Copper Traders Most Bearish in Month as Demand Seen Stalling
- One Putin Ally Sells Stake in Chemical Maker to Son of Another
The Hedgeye Macro Team
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Although our short thesis is complicated, it can effectively be boiled down to one chart.
MCD plans to release August sales numbers on September 9th and we have a sneaking suspicion it will be a negative event. In all likelihood, it will lead the street to revise down its full-year sales and earnings estimates.
Recall that McDonald's global same-store sales declined -2.5% in July and we'd expect August to yield similar results.
In July, performance by segment was:
- U.S. -3.2%
- Europe +0.5%
- APMEA -7.3%
Currently, 3Q14 consensus estimates by segment are:
- U.S. -2.0%
- Europe -0.7%
- APMEA -5.8%
EPS Estimates are too Aggressive
Consensus currently expects MCD to report flat sales and earnings growth in 3Q14. This looks aggressive, however, considering system-wide sales declined -0.5% in July and are likely to be down again in August. Flat sales growth is too optimistic and, given the negative leverage inherent in the business model, reporting a flat EPS number is also unlikely.
The street expects MCD to post $1.52 in earnings in 3Q14 after posting the same number last year. It also expects MCD to post 1.4% EPS growth in 4Q14. Both of these numbers are, in our view, aggressive.
With a recovery, albeit minor, built into 4Q14 estimates, the trend line is expected to accelerate to 8% EPS growth by 1Q15 and stay at that run-rate for the remainder of 2015. We often hear the bulls cite easy comparisons to defend their optimism, but the reality is we've been hearing that for several years. 2014 was a time of easy comparisons for the company and it isn't close to hitting estimates published at the beginning of the year.
From our perspective, management isn't willing to take the necessary steps to fix the business and, until this happens, we expect MCD to consistently underperform expectations.
Risk/Reward Setup Suggests the Stock Is a Short
MCD is currently trading at 15.9x the NTM EPS of $5.87, but looks substantially more expensive when assuming that $5.87 is far too aggressive. Barring some unexpected event, the odds that MCD delivers 8% EPS growth in FY15 are slim-to-none.
We believe that in 2014 MCD could report its first down year in EPS growth since 2002, as we expect full-year EPS to come in between $5.40-5.45 or 2-3% below the current consensus estimate. More importantly, we suspect McDonald's will even struggle to grow EPS off of this lower $5.40-5.45 base. As a result, our 2015 EPS estimate of $5.45 is nearly 10% below the current consensus estimate of $6.02.
Looking out over the next six months, assuming a constant multiple of 15.9x on our NTM EPS estimate of $5.40 gives us an $85 stock representing approximately 9-10% downside from current levels. We understand this is not a "major blow-up," but if the stock saw a little multiple compression (down to the 14-15x range) we're talking about 15-20% downside or about a $12-20 billion decline in market cap.
Feel free to email or call with questions.
Takeaway: Positive catalysts could continue recent share price momentum
Wall Street is on the way to digesting the Prestige acquisition. Where do we go from here?
THE CALL TO ACTION
Similar to many in the investment community, we believe the Prestige deal makes a lot of sense and this week’s stock price surge was warranted. We had already highlighted a positive pivot for NCLH cruise pricing as a result of our survey two weeks to go. As a result, consensus Q3 earnings of $1.08 looks beatable. While the Q4 outlook is a little tenuous for the Caribbean, Prestige’s contribution will be evident. Our synergy forecast is higher than guidance, making current 2015 EPS estimates look conservative. We’re at $2.85 versus the Street at $2.62.
In this note, we focus on the important go forward issues related to the Prestige acquisition:
Strong yield growth
Prestige Cruise International has seen outstanding results the past 4 years due to strong yield growth stemming from an incredibly resilient luxury/premium consumer and the addition of a couple of new Oceania ships. 1H 2014 is off to a good start and we think 2H will be just as good or better; one catalyst is the end of the Insignia 2-yr charter this past April. 2015 should be a solid year as well. The stability of their bookings due to a long lead time (up to 20 months in advance) bodes well for the brands, Regent and Oceania.
Expansion into Asia Pacific
With the acquisition of Prestige, NCL will have a presence in the emerging markets such as China. Based on our analysis from proprietary sources, we believe Prestige’s Asia-Pacific exposure is about 15%, as calculated by estimated capacity days; if Australia itineraries are included, Prestige’s Asia-Pacific capacity of a % of total capacity would be in the 20%s.
While success is highly uncertain in such a market as China, NCL cannot afford to be left behind by RCL and CCL if their gambles pay off in 2015 and beyond. Emerging markets’ cruise business has been growing faster than that in North America and a partnership with Prestige may help alleviate some concerns when NCL do decide to dip their toes in the nascent Asia-Pacific market.
SYNERGIES TOO LOW:
Is the $25m considered too conservative? With $25m in synergies, the NCL-Prestige combo would generate 7% EPS accretion in 2015. We think this is low-hanging fruit and synergies of $40m in 2015 would not be an aggressive target with an additional $20m of synergies in 2016.
We believe most of the cost synergies will lie in corporate overhead efficiencies and better port contracts. As outlined in their presentation, other cost synergy opportunities include customer acquisition costs, purchasing/distribution, fuel, and payroll. Furthermore, according to Norwegian, Prestige has much room to improve on fuel costs.
Some revenue synergies could include: 1) Norwegian should be able to cross market Prestige’s established customer base to help grow The Haven concept. 2) Affluent couples who cruise on Oceania and Regent may consider Norwegian when thinking of a family vacation with kids. 3) Pride of America’s Hawaiian business may become stronger due to changes in marketing tactics.
Genting HK can still sell their shares at any time. It appears that Genting was fine with the deal - not expressing overwhelming support for the addition of Prestige or discontent at the dilution that comes from the new equity offering (20.3m shares). Pro-forma ownership is as follows: Genting HK (25%), Apollo (25%), TPG: 7%, Public shareholders (43%). Only the 20.3m new shares are locked up until end of 2015. The Genting overhang is real but probably mostly priced in.
We applaud management for structuring this deal with Prestige. It sets Norwegian on a different trajectory of growth and more importantly, gives it influence in competing in two areas where it has been largely absent—the premium/luxury consumer and the emerging markets. Accretion is always nice too.
This acquisition does not eliminate the concerns currently surrounding NCLH, which include the prevailing weakness and new competition in the Caribbean, volatile new ship premiums and the risk of Genting/other private equity owners selling shares.
Nevertheless, we believe this deal is a good one and is an example of Norwegian’s long-term commitment to fast growth. On a valuation basis, NCLH is the cheapest in the industry at 13x 2015 P/E (RCL: 14x, CCL: 16x), even after the recent move higher.
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